Good morning, ladies and gentlemen. Welcome to the Bodycote conference call. My name is Leona, and I will be coordinating the call today. During the presentation, you will have the opportunity to ask questions by pressing star followed by one on your telephone keypad. Alternatively, if you'd like to ask a question via the webcast, please use the question box located above the slides. I will now hand you over to your host, Stephen Harris. Thank you.
Good morning, everybody. This is Stephen Harris. Welcome to the Bodycote 2020 interim results presentation. I am here with our Chief Financial Officer live and in person, Dominique Yates.
Morning.
So, without further ado, let's move forward. Before we actually go into the financial results for the half, it would be remiss of me if we didn't at least mention a little bit about what's been happening in these extraordinary times of the pandemic. And my hat's off, actually, to our employees in the company who've done the sterling job of plotting our way through the situation. We've actually had, of course, the employee health, safety, and welfare as top of our agenda during this time. We've been actually putting in place a very good set of health measures at work and also looking after the welfare of some of the people that we've had to lay off temporarily. So we've continued pension contributions whilst they've been on layoff.
And indeed, in places like the United States where the social welfare net is not that strong, we've continued to provide extra support. So we're providing health insurance, full coverage for our employees on temporary layoff in the U.S. We remain mostly open as our facilities have been designated as providing essential services, supporting our customers. And of course, the whole time, we've been balancing this with continued investment to make sure that our shareholders also get good returns. So the agenda for this morning, I'll give you a quick overview and then take you into the business review. Dominique will do a financial review, and then we'll come back and take a look at the outlook. So, from an overview standpoint, I mean, clearly, our results have been significantly impacted by the pandemic. We, we've restructured or put in place restructuring plans.
We are in the process of restructuring. That's something that we did announce earlier, before the pandemic actually started. We just expanded, and I'll talk more about that later. But we expect to have GBP 58 million of annualized savings from that restructuring plan. We've continued to invest for future growth. So we obviously paid GBP 94 million so far for Ellison, but we also have put extra expansion capital in terms of putting in some new facilities. In terms of the actual half-year results themselves, a resilient margin performance, holding at 12.3%, and excellent cash flow. I mean, nearly GBP 70 million of free cash generated in the half, compared with last year of GBP 44.6 million. Revenue down, constant currency, nearly 17%. And that's driven by the Q2 organic revenue, down 33%. So a big hike down in Q2 as the pandemic started biting. Headline operating profit, GBP 38 million.
and a very good operational gearing at 42%. And our business doesn't have naturally variable costs. All of the costs that be varied have to be done with management actions. So having an operational gearing at 42% for this kind of business is a good performance. Turning to the dividend, so we decided to pay the 2019 deferred dividend. And that was the dividend that we announced was going to be our final dividend. And we deferred the decision on that. We're gonna pay that at GBP 0.13 in September. The 2020 interim dividend itself is something that we'll take care of later. So we'll make a decision on the details of that in due course. So coming into this situation, Bodycote was actually very well placed to respond to the demand shocks, downward demand shock from the pandemic.
And some of the reasons for that is so matching resources to demand has become a core skill in Bodycote. It's something we have to do actively, as I mentioned before, and we know how to do it and do it well. It so happens that we did a comprehensive site and capacity review at the end of 2019, that we were looking to do, restructuring on the backhaul, mostly because of long-term trends that we've been observing. And so we already had a very full understanding of where our business was and where it needed to go. It's also interesting to note that every year, as part of our budget and planning exercise, we do do site-by-site contingency plans, in case of demand shocks, both up and down.
So we're all used to actually planning ahead of time for these things and not leaving it to the last moment when something actually happens. As we came into this downturn, we had very strong margins and a low level of debt. I think it's important to note that, actually, the Bodycote business model is very flexible. Today, a business that actually is supplying into aerospace, tomorrow could equally well be supplying into General Industrial or Automotive. There, it's not a technical limitation of our equipment. What focuses our processes on a particular end market is marketing, as opposed to the actual technicalities of the process itself. It's marketing and quality systems and the like, which are different for different sectors. So we're quite flexible in terms of being able to redirect our physical capacity to any particular market.
So immediately as we came into Q2, we started taking cost actions. We're running at about GBP 7 million a month of cost savings. We laid off 797 full-time employees, 14% of the workforce. That includes, actually, our temporaries. So the majority of the temporaries have been laid off. And of course, they exist anyway in our business to provide us with a cushion during downturns. Then we've got about another 619 on short-term layoff. That's another further 11% of the workforce. We've received GBP 2.3 million in government subsidies for our labor around the world, but we've decided that we're going to be repaying the U.K. government furlough support that we've received. We've obviously, as I think most people have done, really leaned heavily on our discretionary spending to reduce it. We've also temporarily closed some sites and consolidated work into fewer sites. That gives us better equipment utilization and efficiency.
It's worth pointing out that we haven't taken any so-called pandemic-related costs to exceptions. They're all, all flowing through the P&L. The only thing in exceptionals is our restructuring program. So just to see how that's, how that's manifested itself in terms of margin management, if we take out the depreciation element, which clearly we can't affect in the near term, then you can see at the EBITDA level, our 2020 margin, in half one is a very respectable 26.4%, compared with, what we were last year at 28.8%. I would, I would suggest that 26.4% is actually an EBITDA margin that many companies would aspire to in normal times, never mind in, in times, of downturn like this. Then if we come to the more permanent cost savings, and I, I think this needs, a bit of explanation.
But we are gonna get GBP 58 million of annualized cost savings or 10% of our operating expenses. These savings will be fully in place by the beginning of 2021, and they're progressively going in place now. It's important not to double count here. So we've got GBP 7 million a month of temporary savings. We will see some of our people on temporary layoff coming back in. And in other locations, we'll be seeing people going out as we close facilities. And we've actually announced 18 plant closures, but it's important to note that we're not getting rid of the physical production capacity. We're moving equipment to other sites. It's the actual sites that are being closed. That reduces our overhead burden. It also, we're taking out the people associated with that.
Overall, we are targeting roughly, in most segments, to be at a running capacity at 20% below 2019 levels. That doesn't mean we expect to be there. That's where we're putting our capacity in terms of people. If it's higher than that, which we would hope it would be, then, we would, in fact, bring back people, on temporary contract to rebuild our buffer in terms of, workforce. You can see on the slide there that, 13 of the closures are in Western Europe, majority in the automotive area. We had said, as part of our restructuring plan, that we expected to, take our capacity in automotive down in Western Europe, as we've seen a longer-term trend towards, electric vehicles, primarily in the Eastern Europe scenario. So that's part of our restructuring program that, we've been doing from a strategic standpoint previously.
I think it's important to note that this whole restructuring program is not a quote-unquote reaction to the pandemic. It's about repositioning the business to the situation that we see after this pandemic is over. We've got four in North America being closed, three automotive, one aerospace, and one in Hungary. But then on top of that, we're opening three. So we're replacing the Hungarian plant, and two of the facilities in North America are being replaced with brand new facilities. In total, 17% of the workforce reduced. And as I said, this will all be in place by the beginning of 2021. So just moving on now to slide 10. And here you can see a slide that we've shown several times before. It gives you a snapshot, three different views into the company.
You can see each of the markets by geography and end markets, the way the growths have gone. Unfortunately, the word growth in this situation means decline. We've seen a variety of declines across the world and in the different market segments. So, aerospace and defense in the half only down 8% so far. We'll come into more detail on these. General industrial down 12%. Clearly, a much bigger hit in automotive. Emerging markets not doing too badly at the moment. Indeed, in the second quarter, China itself grew 8%, and we're seeing quite a strong growth as we come out of the half now in those areas. Just looking for a moment at Specialist Technologies versus Classical Heat Treatment. This has been bulking up on Specialist Technologies as being part of our ongoing strategy.
And you can see on the pie chart in this, slide 11, we're showing that on a pro forma basis, post the acquisition of Ellison, that Specialist Technology is now, in terms of about 30% of group revenues. During the, this pandemic, issue, we've got Classical Heat Treatment declined 21% on a like-for-like basis, whereas, Specialist Technology is down 8%. But if we exclude the acquisition of Ellison, Specialist Technology was down 16%. So about a 5% differential to the Classical Heat Treatment decline. Ellison Technologies itself, this, the acquisition, I think we are pleased with it. It's not gonna be the absolutely fantastic acquisition that we thought it was, originally, given the, the downturn in, in, aerospace, but still a good, a good acquisition. We saw in Q2, Ellison's, revenues decline somewhat faster than the rest of aerospace.
The reason for that is it's tied quite closely to GE. GE, of all the aerospace players, actually immediately shut down production around the world, particularly in North America, and we expect to see, therefore, Ellison rebound faster than the rest of aerospace because as GE's opened up its facilities, their production's coming online much faster. First impressions of the business are good, in line with what we expected, and the integration is proceeding well. So let's just take a trip now through each of the major segments and talk through what's going on, try and give you a bit of color there. Automotive, 23% of the group these days. Year-on-year decline of 31%, quite significant. In Q2, you can see it's 53% down.
The reasons for the very large downturn is that we saw almost universally around the world all the OEMs shutting their doors, as we came into Q2, to try and eliminate production or actually eliminate production. What's happened, then as we've come to the back end of Q2 into the end of the half is that they've reopened. And as a result, we're seeing the output turn up and sales turn up in automotive. It's most strongly noted in North America. There's been an ongoing trend over time in North America for growing preponderance of SUVs and light trucks. And indeed, that's accelerating. We believe that's being helped by the low fuel prices that are there. But clearly, that's the direction that North America's going with a strong rebound occurring. Europe is lagging. It's much slower than North America.
What we've seen in Europe is the first things turning up in Europe are, in fact, the supply chains for Asia. So you see safety equipment, things like seatbelt clips and brake components being manufactured in Europe for Asia, and they've turned up the fastest, supplying particularly into China. And this ongoing trend that we've been seeing continues where we see electric vehicle production escalating in Eastern Europe at a slow rate, but it's moving that way. So that's the automotive picture. If we move on to aerospace and defense, this is a little bit more complicated, though, as I talk this through. Year-on-year, 8% down. Q2 down 28%. Now, the supply chains in aerospace reacted somewhat slower. It's important to note that in automotive, there wasn't a lot of inventory coming into this situation. It's similar to some other segments.
But in aerospace, there has been, and so the downturn in aerospace has been a little bit slower. We expect the downturn in aerospace to actually deepen somewhat in the near term here. But the picture for the longer term, medium term, is quite good in aerospace for Bodycote, and we're a little bit different from many, I think. So if we look, generally speaking, wide-body production's down about 50%, and narrow-body production's down 20%-30% depending on which geography and planes you're actually looking at. And as we go forward, we see a shift in mix towards narrow-bodies, which is quite important for us. So the other thing that we see is that we expect Revenue P assenger Kilometers to get back to by 2023-2024 to 2019 levels.
And the total engines produced, so that's wide-body plus narrow-body engines, beating 2019 in about the same timeframe. Now, if you realize that, in the last five years or so, our mix has shifted quite strongly towards engines used on narrow-bodies. We have a growing amount of our business on narrow-bodies. And indeed, as the number of narrow-bodies is going up at the fastest rate, that means in total, Bodycote's actually positioned in exactly the right place to take advantage of the recovery here. That's both because we were on the LEAP platform, which is a narrow-body engine, and indeed also, it's helped by the acquisition of Ellison, which has got a lot of narrow-body exposure. Important to understand that now the situation that we have is the value add per engine is irrespective of the size.
It doesn't matter whether it's a wide-body engine or a smaller narrow-body engine. We make the same kind of money on both. And so when you add all that up, by the time we get to 2023, 2024, we're in quite a strong position, and we see growth rates going up from there on in. Turning to General Industrial, this is a very diverse market for us. Obviously, it's everything other than aerospace, defense, automotive, and energy. So it's a very wide front here. Overall, in the half, down 12%. The diversification provides some downside protection in this business. So Q2 was only down 19%. And some parts of General Industrial are up. Some parts are down. So for example, medical revenue's up 2%. We've seen electrical electronics up, but tooling, which is primarily linked to large tools for automotive, down 20%.
The capital goods segments within general industrial 'cause it's a mix of CapEx and OpEx that drives this business, they're weak as people have deferred their CapEx investments. But we've also seen supply chains destocking. But once again, like automotive, the supply chains in general industrial in general have fairly low inventories coming into this downturn. And so what we will see is that as destocking stops, which will be happening over the near term now, we believe, then our production levels 'cause we're supplying into inventory for our customers will take a tick up to meet our customers' production levels. I mean, clearly, general industrial, which follows directly on from industrial production, is down further than AGI is. And that is due to the destocking element.
So as destocking ends, we'll kick back up to industrial production levels that are seen in the wider economy. Turning to energy, not a lot to say for energy. It's only 9% of our revenues these days. Year-on-year decline of 16% with 26% in the quarter. Onshore oil and gas, for that, it's primarily North American onshore. And indeed, it's primarily Permian Basin. We've come to the conclusion that that area of our business is not something that is got a rosy future, and we don't intend to expand our investment in that area. In fact, we're doing quite the opposite, and redirecting business capacity there to other areas. Subsea oil and gas is somewhat different. It's on a longer wavelength. There's some momentum there that is encouraging, but we're watching it carefully. And of course, we have two of our Specialist Technologies that service the subsea arena.
So in summary, we've taken very decisive action during this extraordinary period. We've got excellent cash flow, nearly GBP 70 million in cash flow, good operational gearing, and resilient margins. And our balance sheet is strong. I mean, we finished the half with net debt of only GBP 23.6 million, which is lower than we had last half year. And we've paid GBP 94 million for Ellison in the meantime. So we have a very good cash performance. What to expect? Well, we'll come back and look at the outlook in some more detail. But basically, we see a weak short-term demand for aerospace, however, picking back up to put us back in a higher position by 2023, 2024. Automotive markets are already improving from quite a low level that they went down to. And the GI markets, recovering and ending destocking will help that.
So with that, I'm gonna hand over now to Dominique, and he'll take you to the financials.
Thank you, Stephen, and good morning, ladies and gentlemen. Chart 18 summarizes the group's financial results, and you can see here the significant impact from the revenue downturn. Margins were a resilient 12.3% in the half, and as you've already seen, this decline in margin results mainly from the impact of fixed depreciation costs being divided into the lower revenues. Cash flow was strong, and I'll come back and talk about that later. We took a charge of GBP 32.1 million in the first half for restructuring, which we've treated as an exceptional item. And of this, GBP 20.1 million relates to cash items with the remainder, non-cash, impairments. Only GBP 2.8 million of the GBP 20.1 million cash items have actually been spent in the first half.
So from a cash flow perspective, you should expect that the significant majority of the remainder will be incurred during the second half. Also, given the group's performance in cutting costs in reaction to the revenue downturn, as well as the excellent cash flow performance, the board has determined that it's now appropriate to pay the deferred 2019 dividend in the amount of 13.3 pence per share. This dividend will be paid in September. Chart 19 shows the operating profit bridge. And again, here, you can clearly see the negative impact on the group result from lower volumes. It also shows the contribution to the lowered costs from the group's variable pay schemes. While these schemes are designed to incentivize performance in a downturn, they clearly also contribute to softening the negative impact on the business of the lower volumes. Chart 20 shows the division's performances.
ADE's margins retained a very respectable level of 20% in spite of the revenue reduction, while AGI experienced the more significant immediate impact with automotive revenues being down 53% in the second quarter, as we've already covered. This also demonstrates why most of the restructuring effort has been focused in AGI, which accounted for 14 of the 18 announced plant closures. Chart 21 presents the group's results by major currency. This shows that our euro and U.S. dollar businesses are almost now exactly the same size and also represent an equivalent amount of the group's profits. It also demarcates a little the countries in Euroland where labor costs are more difficult and time-consuming to take out compared with other areas of the business elsewhere where adjustments are more straightforward.
And I think it's also worth noting that it shows the good margins that we make in our emerging markets business. Our emerging markets business is mostly in that other category, and you can see that that represents a higher proportion of the profitability than it does on the revenue. So, good margins in our other markets business. Chart 22, the highlight of the first half performance has undoubtedly been our free cash flow generation. Now, of course, you can see that there has been a significant contribution to this from the improved working capital position as a result of lower receivables from the lower revenues. And this will begin to reverse as we see revenues improve. Nonetheless, we successfully cut our costs immediately, and we've also spent less on maintenance CapEx in line with the lower equipment usage.
I also mentioned already that we've the GBP 2.8 million pounds there that we've got in restructuring costs spent in the first half, and it's worth just noting that we have deducted that from the free cash flow. On chart 23, taking a look at the balance sheet, net debt is at GBP 23.6 million. It's actually lower than the equivalent position at the end of first half 2019 and after paying the GBP 94 million of consideration for Ellison. In terms of liquidity, we're in a very strong financial position. We have GBP 204 million of committed headroom, and our revolving credit facility has still five years to run. Finally, headline tax rate 22.5%, bang in line with the guidance that we gave at the full year results. And with that, I'll hand back to Stephen.
Thank you, Dominique. Okay. So let's, let's, let's look forward now. I think it's worth, at this point, just, reminding ourselves as to what the key attributes are of this business. So leaving behind the half, what have we what, what have we got here as a business looking forward? I think it's pretty evident that this is a highly cash-generated business. It has been through thick and thin, even through downturns as severe as this. Our margins are resilient. We're showing that time and time again. And if you can have resilient margins in this kind of environment, you have to know that this business is very robust. We do have a low level of debt, and we've got a very flexible business model that we can turn around to suit to, address markets as they as they come on stream and as they grow.
We've taken the opportunity here to right-size the business, so that we know that we'll be generating good returns once the recovery occurs and beyond. And it's important to note, I think, that operating margins post this restructuring will end up being higher than the previous historic level, levels that we saw. So, when the revenues recover, we will get to higher margins than we've seen in the past. And the final bullet on this slide is that we are well positioned now to capitalize on growth opportunities across all the geographies and market sectors that we serve. That brings us to the outlook statement itself. I don't intend to read this word for word. It is what we've published out there. But overall, I think we're in a very good position. With that, we'll take questions.
Thank you. As a reminder, ladies and gentlemen, if you would like to ask a question, please press star followed by one on your telephone keypad. Alternatively, if you would like to ask a question via the webcast, please use the question box located above the slides. We have our first question from Michael Tyndall of HSBC. Your line is now open, Michael.
Yeah, hi. This is Michael Tyndall. Just a couple from me. Can we talk around general industrial and destocking? I know it's probably an impossible question, but what's your sense in terms of where we are on inventories? We started low. We've gone lower. Are we kind of at the trough now? Then the second question, I think the last time we spoke, there was a mention that with what's going on with your customers, there is a sense that they may actually start to think about outsourcing, which could be quite beneficial. Could you talk a bit about what those, how those conversations may be progressing? And if it does happen, what's the realistic timeline for to see an uptick in outsourcing? Thanks.
Okay. Thanks. Yeah, I thought you changed your name when we saw it come up here, actually, while I was there.
So.
Getting confused with the more famous one.
Yeah, exactly. So yeah, the destocking question's always impossible to answer. I mean, we've got thousands of customers out there. The way that we tell is we start seeing them just spike up one by one. At the moment, we're really not seeing that happening much, so we still are in the destocking phase. The only thing I can refer to here is history. So in, you know, in prior downturns, it's normally taken about six or seven months before the destocking comes to an end when they actually clamp down hard. So we've got a few months more to go of that before I think we see the destocking finishing. Having said that, we are actually seeing, you know, some improvements in GI in various territories. North America is actually moving better. But I can't give you any more color than that, actually.
When it comes to outsourcing, that's a very interesting topic. So, I think it will vary by different area. I mean, France is an interesting case because if you were gonna do outsourcing in France, generally speaking, you'd have to enter into a social plan, which, obviously, French companies try to avoid. It's all very difficult to eliminate labor. In this situation, those that are going into social plans will definitely be looking at outsourcing because it's the opportunity to get out from under it from their perspective.
The issue in France and why I highlight it, though, is that the French government, Macron, has actually put in front of people a big temptation because if they want to continue to receive support for labor on short-term work off work time, they have to sign up for two years and not enter a social plan. So the people are facing a binary decision here. They either have a social plan and then take it on the chin in terms of their labor costs in the meantime as the social plan winds its way through, which will be a long time, or they immediately take the government handouts, but then they can't do a social plan. And in that scenario, if they go down the social plan route, we will get outsourcing.
If they don't, then, then it'll just stay in-house. So France is an extreme example. I think in places like the United States, they're much more economically rational about this. Having said that, it's true to say, I think, in the U.S., they've got many, many things on their minds right now, and the discussions on outsourcing have been at a very superficial level. But I do expect them to start kicking in next year sometime. Germany is an area where we've actually downsized significantly in Germany. So I'm not looking to a lot of outsourcing happening in Germany. So the primary targets will be companies doing social plans in France plus the United States. I hope that answers your question.
Yeah, that's perfect. Thank you.
Our second question is from Jonathan Hurn of Barclays. Jonathan, your line is now open.
Good morning, guys. Just a few questions for me. I think first two are just, just on aerospace. So, if we look at that Q2 performance, I think you said aerospace and defense was down 28%. But, in your statement, I think civil in, in Q2 was down 36%. So can we infer from that that, that obviously, defense is performing quite well, or is there just something in there about, the inclusion of Ellison that's kind of making those figures, come through differently? That was the first one.
Yeah, so certainly, defense is performing reasonably well. And that's why you see a difference in the civil aerospace compared with the total aerospace and defense.
Okay. Just maybe a bit more color. Can you just sort of give us the sort of H1 performance in defense, if you could?
It's up 20% in H1. As you probably know, our defense business is mainly U.S. focused. It's up 20% in the first half.
Okay.
By order of magnitude, that's, you know, GBP 4 million worth of incremental revenue from defense. It's still a.
Sure.
A relatively small part of the overall group result.
Sure. That makes sense. Just coming back to civil, obviously, Q2 was tough. You're guiding to a tougher outlook in sort of H2 and potentially into 2021. Can you just give us some color on sort of your outlook in terms of how much more that market can decline for you, please?
Ooh, that's a tough one. The answer is we don't really know, in the near term. Trying to stay away from near-term dynamics, actually, because there's so many moving parts. What we what we're doing is trying to look through it. So, our best visibility starts in about, end of 2021, 2022. We do expect, sort of this year, towards the end of the year, it to be turning up. But again, you know, it, it there's lots of moving parts. You know, 737 MAX is gonna be coming back into service, but the exact timing of that will affect things. Can't really give you color for 2020, I'm afraid.
Okay. That's fair enough. And the last one for me was just, just looking for the second half. Obviously, you've got some costs coming back into the business, and obviously, with the, the restructuring, there's costs coming out. So if we look at that drop-through rate for, for the second half, what kind of level can we, can we expect from you?
I think you should expect a similar level to what we've seen in the first half broadly.
Okay.
I mean, there are moving parts in there, but I think, a fair expectation would be a similar level to what we've seen in the first half.
Okay. Great, guys. Thank you.
Thank you. Our next question is from Andre of Credit Suisse. Andre, your line is now open.
Hi, good morning. It's Andre from Credit Suisse. Thanks for taking my questions. I wanted to pick up first on one of the key attributes, Stephen, that you mentioned about operating margins exceeding historical levels. Maybe looking at it slightly differently, can you give any indication on how far the revenues need to recover for you to come back to the previous level?
That's a mathematical question. I'll give that to the CFO.
I'll need to calculate it. I mean, obviously, with the consolidation, they wouldn't need to come back quite to the same level they were before. But yeah, it would be a few percentage points below where the historic revenue levels were when we should begin to exceed the level of operating profit and thereby have an improved margin.
Right. Yeah, the other way I was thinking about this is, when you said you've got a kind of business at the end of the program, that you're, you're implementing, you'll have the business kind of right-sized for 20% lower volumes. Is that kind of an indication of where, that, that you can generate sort of similar to prior margins, on volumes that are 20% lower? I know there's kind of mixed effect in there between the two divisions, but conceptually.
Yeah, it makes a lot of have an impact. I think we need to get back to you on it, Andre, actually, with the, I don't wanna make a guess, but it's, it's of that order of magnitude probably. But, let's not make a guess.
Are you right-sizing kind of aerospace to lower than 20%, within the mix of, kind of overall program?
No, no, because in fact, aerospace.
Okay.
We expect to be back to 2019 levels by the end of 2023. So no, we're not. We're actually right-sizing far more in AGI than we are in aerospace. I mean, we are going to have a 2020, 2021 sort of hiatus in aerospace, but we don't see it being 20% down, once we get to, you know, the end of 2023. In fact, quite the opposite.
Great. Thank you. And the final thing on aerospace, Jonathan's question, before, there's quite a lot going on in there, as you said. What I wonder is that we've got on one hand, destocking there and on the other hand, maybe not quite sort of mark-to-market to where the production rates are. If you do kind of mark-to-market to where the production rates are for the relevant platforms for Bodycote, what would your kind of current run rate be versus the minus, I think, 36% that you reported?
Oh, wow. Mark to market, not quite sure what you're talking about.
If you just look at what your kind of underlying platforms are being produced at.
Yeah.
What would that mean, for you as a year-on-year decline?
Okay.
Because what's in between is kind of inventory adjustment sort of noise that.
Yeah.
It will balance out.
No, but I mean, the rate that we're seeing at the moment is a combination of wide-body down 50% and then narrow-body down 20%-30% depending whether you're in U.S. 20% or France 30%. So that's where you end up with our Q2 decline. And that's actually gonna be picking up, and don't forget, our exposure is really to engines. It's not really to the planes themselves. And the engine.
Okay.
Pre-production rates are climbing at a higher rate than demand for platforms, which is an interesting phenomenon. So we get very detailed forecasts from our customers, five years out. It's, it's very, very detailed, and then longer.
Yeah.
term. And I suppose if there is an issue in there in any way, shape, or form, it's that their actual planned production rates, they're smoothing the plane build rates somewhat because they're trying to keep their supply chains intact. So in 2021, you're seeing a higher production of engines forecast from these guys than actually planes to go on. So they're actually forecasting an inventory build in the near term because they know if they take it down to the plane build rates, that 50% and 30%, if they stayed at those levels, there would be a whole slew of guys in the supply chain that would go out of business. And so, you know, the engine manufacturers are actually producing at a somewhat higher rate level, and then the plane body's catching up a little bit later.
That inventory effect that you're referring to is not straightforward.
Yeah, thank you for this. That's really interesting. And that's exactly what I was 'cause it looks like your customers are building their own inventory, but they're reducing inventory of parts 'cause then you wouldn't have been down 36% because your run rate is in line with the frames.
Exactly. Well, it's just a phasing issue, and the customers are starting to build inventory.
Right. Got it. Thank you. And if I may, just very final one. Has anything changed on M&A, in the last couple of months since last time you, you updated us? Has there been any movement?
Yeah, that's an interesting one. So, two categories. One is private equity-owned. So there are a couple of assets that have come on the market, somewhat earlier than you would have expected. They're PE-owned. And I think the PE guys are looking at the fact that their debt situation's somewhat dire, because their cash flows are quite a lot down. And I think it's quite important to note that our cash flow performance and our cost savings are not replicated typically across this industry. You know, we are quite different from other people that are out there. So the PE guys are in trouble, and they've put some assets on the market, which we're looking at. Interestingly, the private owners really aren't budging at the moment. And the reason for that is government support.
And I would, if I was a betting man, I'd put money on the fact that once government support in terms of small business loans disappears, which it will in due course, we will then see the smaller private-owned companies coming on the market. So that's kind of the state of play at the moment. It's somewhat of a hiatus on the very small companies, the private owner-managed companies, because they're getting government support, whereas the PE firms are actually going to market. Hope that answers your question.
Very helpful. Thank you very much.
Thank you. As a reminder, ladies and gentlemen, if you would like to ask a question, please select star followed by one on your telephone keypad. Alternatively, if you would like to ask a question via the webcast, please use the question box located above the slides. We have now got a question from Alexander Virgo of Bank of America. Alexander, your line is now open.
Thanks very much. Good morning, gentlemen. I just wanted to pick up on your point there about resizing the business to 20% below 2019 levels in capacity terms. What sort of temporary flexibility do you have? Is there, I think you mentioned 10% as the proportion of the employees that temporary employees that you have already let go as a function of COVID. I'm just wondering if that's a good indication of the plus-minus flexibility that you have in that kind of structural adjustment. And then I wondered if you could maybe give us an indication of the structural adjustment by end market. I appreciate you might not want to go into that much detail, but it would be helpful just to understand which areas of your business are driving that more than others 'cause I'm guessing, obviously.
Yeah.
What you've said so far in aerospace, it's maybe not quite so bad in aerospace.
Yeah, Alexander, I'm sorry about this, but I missed the first part of your question. It was a little bit interrupted there. Could you say it again, please?
Oh, sure. Sorry. So you called structural adjustment in your cost base to 20% below 2019 levels. I was just wondering what the flexibility you have in the team when you hire people on temporary contracts to adjust for flexibility on short-term demand prospects, I suppose. What's the plus-minus flexibility in that structural adjustment, if that makes sense. I'm just trying to get a feel for 'cause obviously.
Yeah.
20% versus 2019 sounds quite a big number, but obviously, if we get some recovery, it hopefully, at least, won't be quite as bad as that. So I'm just trying to understand the flexibility you have with temporary workforce.
Sure.
I wondered if you could provide a bit of color on the end markets. Thank you.
Yeah. So the 20% number is sort of broad brush. I mean, it's less in some areas. I mean, for example, in emerging markets, we are not expecting, well, we haven't planned it being down 20%. You know, in fact, in China, quite the opposite. So but the 20% has been sort of more in the Western markets, and in our older established markets. The blend of it, if you actually look at the permanent headcount reduction, which is part of this issue, it's 17% in total, you know, across the whole group. And most of that is in automotive. So, you know, obviously clearly, there's a lot less reduction in aerospace, and that's the confusion, I think, here.
You know, the aerospace is gonna have a near-term downturn, but it's actually gonna turn up, so as they restock, which is what we addressed on the last question there. In terms of buy-in market by geography, we bring the temporaries on, in the areas where it's very difficult to let people go. So we don't have temporaries in North America to speak of. What we do is we have temporaries in Germany and France primarily. And we find that as a percentage of group headcount, typically, it's around 15% is the kind of level that we can run at maximum. You don't wanna go above that. But we run at about 15% maximum.
So if you say we're down, you know, so 17% in terms of workforce at the moment, we could add 15% of temporaries back onto that to take us up to close to where we were before. In terms of further downturn, I think that's also worth bearing in mind. It's very straightforward for us to reduce headcount, which is our primary cost, of course, in North America and most of Europe outside of France and Germany. It's a relatively straightforward exercise. And having de-emphasized Germany now in our business quite a bit and put the social plans through in France, our downside flexibility in terms of permanent labor, if we had to, is greater than it was before. So, overall, I think, you know, a 15% upside on temporaries, and then we're into hiring people full-time.
Okay. That's really helpful. Thanks.
So I'm guessing, therefore, that auto structurally is, capacity-wise, is gonna be down mid- to mid- to high-20s% or 30% relative to 2019 levels?
20%. We've taken.
Okay.
Capacity.
Okay. Thank you so much.
Yeah, we've retained the equipment.
But we're just to make sure, we've not let the equipment go, so we still got the physical capacity. It's just the people involved and the number of sites. So we've consolidated sites, but we still have the same amount of equipment. I'd just like to answer a question that's come through on the web, if I might, at this point. The question's come in from Céline at UBS. So the question is, what are the suppliers at risk in aerospace? I think I might have confused you there. We don't really have suppliers in the normal sense because we don't process materials at all. So, you know, our suppliers are basically our employees, and also energy and industrial gases. There's no risk on our supply chain.
The risks in the supply chain I was talking about were our customer's supply chain in terms of often, it's the people we deal with 'cause we'll deal with from the OEM all the way down the supply chain. So there are people at risk in the customer's supply chain. One of the things that's happened during this sort of engine supercycle, as they call it, the expansion in aerospace, is there's been a lot of PE going into the aerospace supply chain, and they are definitely at risk. You know, they are strapped, so there's a lot of maneuvering going on in that area, plus the fact there's just too much capacity in the supply chain for the medium term. So definitely, customers out there.
It's nice to note that we don't generally have much money at risk with customers 'cause we're basically being paid on a, you know, sort of on a monthly basis, and we do day-by-day work. It's not like we've got order books at all to worry about. But we keep quite a strong eye on our receivables, and our track record on receivables is excellent. So it's really the customer suppliers that are at risk, not ours. And I think the rest of your questions I've answered. So if we go back to you, operator, are there any more phone calls?
Thank you. Our next question is from Andrew Douglas of Jefferies. Andrew, your line is now open. Andrew? Hello? I do apologize.
Hi there. Most of my questions have been answered, but I've just got a few short ones, if I may. Can you just give us an update on CapEx plans going forward, particularly with regard to expansion of CapEx and maybe emerging markets? Has COVID resulted in any change of thought there, or is that still kind of a plan kind of going ahead? Secondly, just wondering when we should have a decision on the first half 2020 dividend. I appreciate that you've made a big move on the final dividend now, but when will we get a decision on the first half 2021? And secondly, oh, sorry, thirdly. Summer shutdowns. I'm working on the assumption that, actually, summer shutdowns this year might not be quite as bad as in prior years.
I appreciate that doesn't have a huge amount of impact on profitability over the summer, but is that a fair comment as we're looking to the summer? Thank you.
So I'll take the shutdowns and the CapEx, and Dominique can do the dividend. The shutdowns issue is at the moment a big, big unknown. Normally, people do with a shutdown is their maintenance shuts. But as a lot of these guys shut down, particularly in the automotive industry - I mean, they slammed their doors shut - in aerospace, GE shut down, they did do a lot of maintenance work during that time. And indeed, when they opened up, they really only opened up to do maintenance work to start with. So the maintenance aspect of the summer shutdowns is probably not there as a strong push. It will depend on their demand levels are, and that's something that we just can't call.
If demand levels were up or rising, then we would expect shorter summer shuts, but it's hard to call it at this point in time 'cause we just don't have that kind of, you know, the degree of granularity out there.
Okay.
In terms of the CapEx, so I think it's fair to say that the big chunks of CapEx that we do are in HIP services, so, big, you know, chunky vessels for $20 million apiece, kind of numbers, dollars. And I think there is a deferral on that side because with the HIP services business is primarily focused, the major part of it, at least, is on aerospace. And I think the general demand is lower, so we will not need as much expansion capacity as we were previously planning. And so those chunky pieces are probably being delayed two to three years as a result of that. In terms of the rest of it, I think that it will depend on the trade patterns and how they work.
I mean, if we actually are heading for a world where there's less free trade globally and more sort of intracontinental trade, then you will see us investing at a greater rate in the emerging markets than we have up to now. I mean, we've been pushing ahead hard, but I think our greenfield program might actually tick up, because if we're seeing more local trade both in, for example, North America and, you know, China, you can imagine that we'll be putting more capacity on the ground in those areas. But generally, that's the only kind of influences we can see on our CapEx program.
As far as the dividend's concerned, so, Andrew, we're paying the deferred dividend in September. So the thinking is that any interim dividend would probably be paid beginning of next year.
We'll make the determination on that later this year.
Dominique, while I've got you, just a quick question. Have you guys done an impairment review over the half a year? And if so, any thoughts?
Yeah, we have. I mean, the rules are that if your sales trigger the requirement for an impairment review, you have to do an impairment review mid-year. So we've done that, because our rules say that if you're more than 10% below budget - and bearing in mind our budget was a pre-pandemic budget - then that triggers an impairment review. So all bar two of our cash-generating units triggered that review requirement. We've therefore impairment tested all of our CGUs, and none of them required any impairment.
Perfect. Thank you, guys.
Thank you.
Thank you. We have another question from Harry Philips of Peel Hunt. Harry, your line is now open.
Good morning, everyone. In a sense, just refer to it, Stephen, in terms of HIPing. How flexible is HIPing away from aerospace? Is it easy to find alternative, sort of markets, if you like?
Yeah, that's an interesting one. So there are alternative markets, and one of the things that this has caused us to do, 'cause we've, you know, we've been sort of swimming along thinking aerospace is going on forever, that it has caused us to look harder elsewhere. And indeed, there are some markets where we have a very low market share, believe it or not, in HIP services, one of which is, well, I won't go into the details, but we have some areas where we have a low market share that's being served by a different means that we can target. But the primary areas I think we'll go for is our HIP Powder met business because the HIP Powder met business uses HIP services capacity, the big, you know, the big HIPs.
If you think of it in terms of that in sales value, the yield for Powder met is four times that of HIP services. And there's a big, big market to go for in Powder met. So that's where we will be concentrating, plus we'll be looking at some of these other markets that we've ignored, where we can do some substitute work there. So there is some, but clearly, aerospace is phenomenally important. But I think, in overall terms, it just means that we won't need the new capacity that we were planning on in the future. It'll just defer it for by two to three years, that's all.
Excellent. Thank you very much, indeed.
Ladies and gentlemen, if you'd like to ask another question, please select star followed by one on your telephone keypad. Alternatively, if you'd like to ask a question via the webcast, please use the question box located above the slides.
I was hoping we were gonna get another technical question like Andrew's, impairment one, you know, but apparently not.
At this moment, we have no further questions. I'll hand it back to you, Stephen. Thank you.
Okay. Well, thanks very much, everybody. Appreciate it. And, obviously, you know, if you have any further questions as you think about things or get time to digest it, please do give us a call. So all the best. Thanks very much.
Thank you.
Ladies and gentlemen, this concludes today's conference. You may now disconnect your lines.